(Bloomberg) -- Investors in US Treasury debt are bracing for another auction, after sales of two- and five-year notes drew only middling demand — despite yields near the highest levels of the year.
Appetite for short-end debt on Monday failed to benefit from a rise in rates heading into the sales, a poor omen for the week's final note auction of seven-year securities. Yields have jumped across the curve this year, with the benchmark 10-year Treasury now paying about 4.27%, 40 basis points more than at the end of 2023. The seven-year note is yielding 4.31%.
Rates have soared as Treasury investors contend with an erosion in expectations for how much the Federal Reserve will lower interest rates this year — a policy shift that would likely fuel a bond rally — and an onslaught of new corporate issuance that has given yield-seeking investors ample alternatives. Investment-grade companies sold more debt in the US this month than in any other February on record.
“Today's seven-year tenor looks expensive compared to yesterday's five-year tenor, hence I expect another tail at today's auction,” said Althea Spinozzi, head of fixed income strategy at Saxo Bank, using industry parlance to describe a sale that's allocated at a higher yield than indicated by pre-sale trading. “It seems that investors are increasing duration but are cherry-picking tenors across the curve.”
Traders have been moving to price only 75 basis points of US easing by year-end, in line with what Fed policymakers in December indicated is the likeliest outcome. However, even that amount of interest-rate cuts is in doubt, with some investors contemplating the possibility that additional rate increases will be needed.
Fed policymakers have said that while they anticipate cutting rates this year, they first need to see additional evidence that inflation is on a sustainable path back toward their 2% target. The Fed's preferred inflation gauge, the deflator for personal consumption expenditures, is released Thursday and will shed more light on price pressures after a gauge of consumer prices indicated hotter-than-expected inflation in January.
Supportive factors for the seven-year auction include its relatively small size and the potential for demand heading into month-end, when investors typically rebalance their portfolios.
While sales of the two- and five-year notes were a record size, the $42 billion seven-year auction is $20 billion below its peak size reached in 2021. And Treasuries gained last week from anticipation that the end of the month will spur reallocation into bonds following strong performance by equities.
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